Is the Great TV Crunch Coming?

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This week, the biggest players in television and communications have arrived at Sun Valley in an effort to chart out the next year in the industry. Typically, it’s a good place to boast about good earnings, as well as introduce new ways of getting hit shows into more homes, for a fee. While competition has been the driving force in this conference, one man has been publicly taking an alternative approach to competition: consolidation.

Liberty Media’s John Malone has spoken publicly about the benefits of a merger between DirectTV (NASDAQ: DTV) and Dish Network (NASDAQ: DISH) in an effort to lower costs and increase the power of competition. Using the scale economic theory, it is better for companies to merge so that content costs for TV packages can be reduced, making operations cheaper and customers’ bills lower. With a market under threat from companies like Netflix, which charges only $7.99/month for streaming service, and next-day broadcasts from Hulu, a website partially owned by Comcast (NASDAQ: CMCSA), driving down costs to keep customers engaged may be the most pressing matter for the industry, as well as trying to make themselves more technologically advanced.

In programmer vs. provider, the customer never wins

The main concern is obviously reducing costs. According to the theory of economies to scale, some industries that are expensive, like television, require so much investment to be strong, that it is nearly impossible to sustain numerous small players and be affordable. In this case, the limited number of programming companies could raise prices for their products pretty high for smaller companies, knowing that they can, and do, get the deal they want from the big players like Comcast.

In 2012, there was a dust-up between Disney-owned ESPN and Dish over the $6.23 billion subscription fee to carry the channels on the service, which eventually was resolved, but resulted in a 58% net income loss for Dish due to the higher costs that year. Such instances are becoming more common as programming companies like Disney increase their channel offerings, and also increase their costs to companies like Dish to carry them. Also, breaking-up the packages, or “bundling,” is uneconomical because charging by station would drive the prices higher than selling them straight, putting cable and satellite companies in a “my way or the highway” type standoff that leaves customers frustrated and more likely to ditch cable altogether and stick with internet TV, a growing trend over the last few years.

Shaking off Sprint

A Dish-DirectTV merger was Malone’s primary suggestion because Dish has made it known that it's looking to expand its reach in the industry. Dish is coming off a rejected $25.5 billion deal for Sprint and Clearwire that some observers think was only about making it harder for Softbank to close the deal, but was probably an earnest, but late, attempt to help the company in the long run. This means that Dish may be open to joining up with DirecTV to expand the brand. A merger of the two companies would mean a combined 34 million customers in the United States, making it the largest company in the industry with a combined market cap of $54.6 billion, the second largest behind Comcast at $63.2 billion.

Another idea with the same end result would be a proposed merger between Time Warner (NYSE: TWC) and Charter Communications (NASDAQ: CHTR), the latter being 27% owned by Malone, suggesting a potential benefit for him. This combined merger would involve the second and fourth-largest cable companies in the country, a total market cap of nearly $46 billion, and 16 million customers (though Time Warner would provide 12 million of them).

Who can challenge Comcast?

It is worth noting that these potential mergers show how far ahead Comcast is compared to its nearest four competitors in terms of customers and market cap.

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In addition, Comcast has announced that, rather than auction off partially-owned Hulu to Time Warner as originally intended, it will spend $750 million on the website for upgrades and additions. Investing in Hulu, and its next-day streams of popular NBC Universal programming, has been a boost to Comcast’s fortunes, as well as an ability to stay competitive with Netflix in the on-demand market. According to Malone, this makes it that much more important that the companies should merge to stay afloat, because it would mean a better ability to challenge Comcast in the industry.

Bottom line - watch the little guys

Merger news is always a cue for investors to buy. When Dish tried to go after Sprint and Clearwire, the stock rose by over 10% that month. If Malone’s suggestions are taken seriously, that could mean big paydays for DirecTV and Dish holders (though Dish, the smaller company, would be a better beneficiary). The same goes with a merger of Time Warner and Charter, with Charter investors being the better beneficiaries.

Merger plans aren’t in the immediate future, but Dish CEO, Charlie Ergen, has flirted with the idea of a mega-satellite company in the past. He may do so again if the need to stay relevant in a changing climate is great enough. Time Warner and Charter may be the more likely alternative due to their small size and the disparity between them and industry-leader, Comcast. This will be something to watch in the coming years, as well as a sign of whether or not the industry can survive with more people going to Netflix to satisfy their TV cravings. 

The television landscape is changing quickly, with new entrants like Netflix and disrupting traditional networks. The Motley Fool's new free report "Who Will Own the Future of Television?" details the risks and opportunities in TV. Click here to read the full report!

John McKenna has no position in any stocks mentioned. The Motley Fool recommends DirecTV. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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